Solution Manual for Auditing and Assurance Services, 17th edition By Alvin A. Arens, Randal J. Elder, Mark S. Beasley, Chris E. Hogan

Key Audit Assurance Service 17th edition đầy đủ nhất, trọn bộ 670 trang full đáp án Key Audit Assurance Service 17th edition đầy đủ nhất, trọn bộ 670 trang full đáp án Key Audit Assurance Service 17th edition đầy đủ nhất, trọn bộ 670 trang full đáp án

Beasley, Chris E Hogan

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solution manual for

Auditing and Assurance Services, 17th edition By Alvin A Arens, Randal J Elder,

Mark S Beasley, Chris E Hogan

Chapter 1-26

Chapter 1 The Demand for Audit and Other Assurance Services

 Concept Checks

P 8

1 To do an audit, there must be information in a verifiable form and some

standards (criteria) by which the auditor can evaluate the information

Determining the degree of correspondence between information and

established criteria is determining whether a given set of information is in

accordance with the established criteria For an audit of a company‘s

financial statements the criteria are U.S generally accepted accounting

principles or International Financial Reporting Standards

2 The four primary causes of information risk are remoteness of information,

biases and motives of the provider, voluminous data, and the existence of

complex exchange transactions

The three main ways to reduce information risk are:

1 User verifies the information

2 User shares the information risk with management

3 Audited financial statements are provided

P 16

1 The three main types of audits are operational audits, compliance audits, and

financial statement audits The table below summarizes the purposes and

nature of each type of audit

OPERATIONAL AUDITS

COMPLIANCE AUDITS

AUDITS OF FINANCIAL STATEMENTS

PURPOSE To evaluate

whether operating procedures are efficient and effective

To determine whether the client is following specific procedures set by a higher authority

To determine whether the overall financial statements are presented in accordance with specified criteria (usually GAAP)

Concept Checks (continued)

OPERATIONAL AUDITS COMPLIANCE AUDITS

AUDITS OF FINANCIAL STATEMENTS USERS OF

AUDIT

REPORT

Management of organization Authority that established rules,

regulations, and procedures, either internal or external to auditee

Different groups for different purposes — many outside entities

nonstandard;

often subjective

Not standardized, but specific and usually objective

Highly standardized

PERFORMED

BY:

Almost universally

* Internal auditors may assist CPAs in the audit of financial statements Internal

auditors may also audit internal financial statements for use by management

2 The major differences in the scope of audit responsibilities for CPAs, GAO

auditors, IRS agents, and internal auditors are:

 CPAs perform audits of financial statements prepared using U.S

GAAP or IFRS in accordance with auditing standards

 GAO auditors perform compliance or operational audits in order to

assure the Congress of the expenditure of public funds in accordance

with its directives and the law

 IRS agents perform compliance audits to enforce the federal tax laws

as defined by Congress, interpreted by the courts, and regulated by the

IRS

 Internal auditors perform compliance or operational audits in order to

assure management or the board of directors that controls and policies

are properly and consistently developed, applied, and evaluated

Review Questions

1-1 To do an audit, there must be information in a verifiable form and some

standards (criteria) by which the auditor can evaluate the information The

information for Jones Company's tax return is the federal tax returns filed by the

company The established criteria are found in the Internal Revenue Code

and all interpretations For the audit of Jones Company's financial

statements the information is the financial statements being audited and the

established criteria are U.S GAAP or IFRS

1-2 This apparent paradox arises from the distinction between the function of

auditing and the function of accounting The accounting function is the recording,

classifying, and summarizing of economic events to provide relevant information

to decision makers The rules of accounting are the criteria used by the auditor

for evaluating the presentation of economic events for financial statements and

he or she must therefore have an understanding of accounting standards, as well

as auditing standards The accountant need not, and frequently does not,

understand what auditors do, unless he or she is involved in doing audits, or has

been trained as an auditor

1-3 An independent audit is a means of satisfying the need for reliable

information on the part of decision makers Recent changes in accounting and

business operations include:

1 Increased global activities of many businesses

a Multiple product lines and transaction locations

b Foreign exchange affects transactions

2 Complex accounting and exchange transactions

a Increasing use of derivatives and hedging activities

b Increasingly complex accounting standards in areas such as

revenue recognition

3 More complex information systems

a Possibly millions of transactions processed daily through

on-line and traditional sales channels

b Voluminous data requires interpretation

earn by investing in U.S treasury notes for the same length of time

as the business loan

the business will not be able to repay its loan because of economic

or business conditions such as a recession, poor management decisions, or unexpected competition in the industry

upon which the business risk decision was made was inaccurate A likely cause of the information risk is the possibility of inaccurate financial statements

Auditing has no effect on either the risk-free interest rate or business risk

However, auditing can significantly reduce information risk

1-5 The three main ways to reduce information risk are:

1 User verifies the information

2 User shares the information risk with management

3 Audited financial statements are provided

The advantages and disadvantages of each are as follows:

2 User can be more confident

of the qualifications and activities of the person getting the information

1 High cost of obtaining information

2 Inconvenience to the person providing the information because large number of users would be on premises

3 Minimal inconvenience to management by having only one auditor

1 May not meet needs

of certain users

2 Cost may be higher than the benefits in some situations, such

as for a small company

1-6 Information risk is the risk that information upon which a business decision is

made is inaccurate Fair value accounting is often based on estimates and requires

judgment Fair value can be estimated using multiple methods with some estimates

being more subjective than others Fair value estimates are made at a point in time,

but can also change rapidly, depending on market conditions All of these factors

increase information risk

1-7 An assurance service is an independent professional service to improve the

quality of information for decision makers An attestation service is a form of

assurance service in which the CPA firm issues a report about the reliability of an

assertion that is the responsibility of another party

The most common form of audit service is an audit of historical financial

statements, in which the auditor expresses a conclusion as to whether the

financial statements are presented in accordance with an applicable financial

reporting framework such as U.S GAAP or IFRS An example of an attestation

service is a report on the effectiveness of an entity‘s internal control over financial

reporting There are many possible forms of assurance services, including services

related to business performance measurement, health care performance, and

information system reliability

1-8 Some organizations issue sustainability reports to highlight the work they

are doing related to the environment, social issues, and governance (often

referred to as ESG) These reports include different types of data that reflect the

organization‘s overall performance related to their sustainability efforts For

example, some organizations provide data related to carbon emissions, resource

usage, and waste generation to highlight their impact on the environment Others

report demographic data about the types of individuals they hire as employees or

serve as customers Investors and other users of these sustainability reports may

desire assurance from CPAs about the accuracy and reliability of these data

items

1-9 The primary evidence the internal revenue agent will use in the audit of

the Jones Company's tax return include all available documentation and other

information available in Jones‘ office or from other sources For example, when

the internal revenue agent audits taxable income, a major source of information

will be bank statements, the cash receipts journal and deposit slips The internal

revenue agent is likely to emphasize unrecorded receipts and revenues For

expenses, major sources of evidence are likely to be cancelled checks and

electronic funds transfers, vendors' invoices, and other supporting

documentation

1-10 Five examples of specific operational audits that could be conducted by an

internal auditor in a manufacturing company are:

1 Examine employee time records and personnel records to determine

if sufficient information is available to maximize the effective use of personnel

2 Review the processing of sales invoices to determine if it could be

done more efficiently

3 Review the acquisitions of goods, including costs, to determine if

they are being purchased at the lowest possible cost considering the quality needed

4 Review and evaluate the efficiency of the manufacturing process

5 Review the processing of cash receipts to determine if they are

deposited as quickly as possible

1-11 When auditing historical financial statements, an auditor must have a

thorough understanding of the client and its environment, including knowledge

about the client‘s regulatory and operating environment, business strategies and

processes, and measurement indicators This strategic understanding is also

useful in other assurance or consulting engagements For example, an auditor

performing an assurance service on information technology would need to

understand the client‘s business strategies and processes related to information

technology, including such things as purchases and sales via the Internet

Similarly, a practitioner performing a consulting engagement to evaluate the

efficiency and effectiveness of a client‘s manufacturing process would likely start

with an analysis of various measurement indicators, including ratio analysis and

benchmarking against key competitors

1-12 The four parts of the Uniform CPA Examination are: Auditing and Attestation,

Financial Accounting and Reporting, Regulation, and Business Environment and

 Discussion Questions And Problems

1-16 a Audit services are a form of attestation service, and attestation

services are a form of assurance service In a diagram, audit services are located within the attestation service area, and attestation services are located within the assurance service area

b 1 (2) An attestation service other than an audit service

2 (2) An attestation service other than an audit service

3 (1) An audit of historical financial statements

4 (3) An assurance or nonassurance service that is not an

attestation service

5 (2) An attestation service other than an audit service

6 (2) An attestation service other than an audit service

7 (2) An attestation service other than an audit service

(Review services are a form of attestation, but are performed according to Statements on Standards for Accounting and Review Services.)

8 (2) An attestation service other than an audit service

9 (2) An attestation service other than an audit service

11-16 (continued)

10 (2) An attestation service other than an audit service

11 (3) An assurance or nonassurance service that is not an

attestation service

1-17 a The interest rate for the loan that requires a review report is lower

than the loan that did not require a review because of lower information risk A review report provides moderate assurance to financial statement users, which lowers information risk An audit report provides further assurance and lower information risk As a result of reduced information risk, the interest rate is lowest for the loan with the audit report

b Given these circumstances, Monterrey should select the loan from

First City Bank that requires an annual audit In this situation, the additional cost of the audit is less than the reduction in interest due

to lower information risk The following is the calculation of total costs for each loan:

LENDER

CPA SERVICE

COST OF CPA SERVICES

ANNUAL INTEREST

ANNUAL LOAN COST

Southwest National

Bank

c Monterrey should select the loan from Southwest National Bank

due to the higher cost of the audit and the reduced interest rate for the loan from Southwest National Bank The following is the calculation of total costs for each loan:

LENDER

CPA SERVICE

COST OF CPA SERVICES

ANNUAL INTEREST

ANNUAL LOAN COST

Southwest National

Bank

d Monterrey may desire to have an audit because of the many other

benefits that an audit provides The audit will provide Monterrey‘s

management with assurance about annual financial information used for

decision-making purposes The audit may detect errors or fraud, and

provide management with information about the

1-17 (continued)

effectiveness of controls In addition, the audit may result in recommendations to management that will improve efficiency or effectiveness

e The auditor must have a thorough understanding of the client and its

environment, including the client‘s e-commerce technologies, industry, regulatory and operating environment, suppliers, customers, creditors, and business strategies and processes This thorough analysis helps the auditor identify risks associated with the client‘s strategies that may affect whether the financial statements are fairly stated This strategic knowledge of the client‘s business often helps the auditor identify ways to help the client improve business operations, thereby providing added value to the audit function

1-18 a The services provided by Consumers Union are very similar to

assurance services provided by CPA firms The services provided

by Consumers Union and assurance services provided by CPA firms are designed to improve the quality of information for decision makers CPAs are valued for their independence, and the reports provided by Consumers Union are valued because Consumers Union is independent of the products tested

b The concepts of information risk for the buyer of an automobile and

for the user of financial statements are essentially the same They are both concerned with the problem of unreliable information being provided In the case of the auditor, the user is concerned about unreliable information being provided in the financial statements

The buyer of an automobile is likely to be concerned about the manufacturer or dealer providing unreliable information

c The four causes of information risk are essentially the same for a

buyer of an automobile and a user of financial statements:

much information about either an automobile manufacturer

or the automobile itself without incurring considerable cost

The automobile buyer does have the advantage of possibly knowing other users who are satisfied or dissatisfied with a similar automobile, and the ability to perform online research

of new vehicles

the automobile buyer and the manufacturer The buyer wants

to buy a high quality product at minimum cost whereas the seller wants to maximize the selling price and quantity sold

(3) Voluminous data There is a large amount of available

information about automobiles that users might like to have

in

1-18 (continued)

order to evaluate an automobile Either that information is not available or too costly to obtain

automobile is expensive and certainly a complex decision because of all the components that go into making a good automobile and choosing between a large number of alternatives

d The three ways users of financial statements and buyers of

automobiles reduce information risk are also similar:

by driving different automobiles, examining the specifications of the automobiles, talking to other users and doing research in various magazines

manufacturer of a product has a responsibility to meet its warranties and to provide a reasonable product The buyer

of an automobile can return the automobile for correction of defects In some cases a refund may be obtained

This is similar to an audit in the sense that independent information is provided by an independent party The

information provided by Consumer Reports is comparable to

that provided by a CPA firm in an audit of financial statements

1-19 a The following parts of the definition of auditing are related to the

narrative:

(1) Altman is being asked to issue a report about qualitative and

quantitative information for trucks The trucks are therefore

the information with which the auditor is concerned

(2) There are four established criteria which must be evaluated

and reported by Altman: existence of the trucks on the night

of June 30, 2019, ownership of each truck by Regional Delivery Service, physical condition of each truck and fair market value of each truck

(3) Samantha Altman will accumulate and evaluate four types of

evidence:

(a) Count the trucks to determine their existence

(b) Use registration documents held by Burrow for

comparison to the serial number on each truck to determine ownership

(c) Examine the trucks to determine each truck's physical

condition

(d) Examine the blue book to determine the fair market

value of each truck

1-19 (continued)

(4) Samantha Altman, CPA, appears qualified, as a competent,

independent person She is a CPA, and she spends most of

her time auditing used automobile and truck dealerships and has extensive specialized knowledge about used trucks that is consistent with the nature of the engagement

(5) The report results are to include:

(a) which of the 25 trucks are parked in Regional's

parking lot the night of June 30

(b) whether all of the trucks are owned by Regional

Delivery Service

(c) the condition of each truck, using established

guidelines

(d) fair market value of each truck using the current blue

book for trucks

b The only parts of the audit that will be difficult for Altman are:

(1) Evaluating the condition, using the guidelines of poor, good,

and excellent It is highly subjective to do so If she uses a different criterion than the "blue book," the fair market value will not be meaningful Her experience will be essential in using this guideline

(2) Determining the fair market value, unless it is clearly defined

in the blue book for each condition

1-20 a The major advantages and disadvantages of a career as an IRS

agent, CPA, GAO auditor, or an internal auditor are:

INTERNAL

REVENUE

AGENT

1 Extensive training in individual, corporate, gift, trust and other taxes is available with concentration

in area chosen

2 Hands-on experience with sophisticated selection techniques

1 Experience limited to taxes

2 No experience with operational or financial statement auditing

3 Training is not extensive with any business enterprise

1-20 (continued)

CPA 1 Extensive training in audit of

financial statements, compliance auditing and operational auditing

2 Opportunity for experience in auditing, tax consulting, and management consulting practices

3 Experience in a diversity of enterprises and industries with the opportunity to specialize in a specific industry

1 Exposure to taxes and to the business enterprise may not be as in-depth as the internal revenue agent

or the internal auditor

2 Likely to be less exposed

to operational auditing than is likely for internal auditors

INTERNAL

AUDITOR

1 Extensive exposure to all segments of the enterprise with which employed

2 Constant exposure to one industry presenting opportunity for expertise in that industry

3 Likely to have exposure to compliance, financial, and operational auditing

1 Little exposure to taxation and the audit of taxes

2 Experience is limited to one enterprise, usually within one or a limited number of industries

GAO AUDITOR 1 Increasing opportunity for

experience in operational auditing

2 Exposure to highly sophisticated statistical sampling and computer auditing techniques

1 Little exposure to diversity

of enterprises and industries

2 Bureaucracy of federal government

b The two best choices for the senior interested in becoming a

certified fraud examiner would be starting out as either a CPA or an internal auditor A CPA gains experience with internal controls and has an understanding of incentives and opportunities to commit fraud An internal auditor gains experience with internal controls and has an in-depth understanding of operations and the many facets of a business IRS agents and GAO auditors would be in demand for fraud examinations relating specifically to tax fraud or governmental entities

c Other auditing careers that are available are:

 Auditors within many of the branches of the federal government

(e.g., Department of Homeland Security)

 Auditors for many state and local government units (e.g.,

state insurance or bank auditors)

1-21 The most likely type of auditor and the type of audit for each of the examples

are:

1

2

3

4

5

6

7

8

9

10

11

12

Internal auditor or CPA CPA

Internal auditor or CPA Internal auditor or CPA Internal auditor or CPA CPA or internal auditor GAO

CPA GAO GAO IRS IRS

Financial statements or operational Financial statements

Compliance Compliance Operational Financial statements Operational

Financial statements Financial statements Compliance

Compliance Compliance

1-22 a Financial statement audits reduce information risk, which lowers

borrowing costs An audit also provides assurances to management about information used for decision-making purposes, and may also provide recommendations to improve efficiency or effectiveness of operations

b Czarnecki and Hogan likely provide tax services, accounting

services, and management advisory services They may also provide additional assurance and attestation services other than audits of financial statements

c Student answers will vary They may identify new types of information

that require assurance, such as environmental or corporate responsibility reporting Students may also identify opportunities for consulting or management advisory services, such as assistance with the adoption of International Financial Reporting Standards

1-23 a Assurance related to financial statements are the most likely forms

of assurance that are likely to be provided only by public accounting firms Examples include audits of historical financial statements, reviews of historical financial statements, audits of internal control over financial reporting, and compliance auditing such as that required by the Single Audit Act and OMB Circular A-133 (although these audits may also be provided by government auditors)

1-23 (continued)

b There are many types of information that are assured by providers

other than public accounting firms Some of these assurances are provided by government entities, such as food inspections, elevator inspections, and pumps at gasoline stations Other assurances are provided by nonprofit and for-profit assurance providers, such as ISO 9000 certifications

c Table 1-1 on p 11 includes some examples of assurance that may

be provided by public accounting firms or other assurance providers For example, assurance on corporate responsibility and sustainability may be provided by public accounting firms or other assurance providers Other examples included assurance on website controls, and information such as website traffic or newspaper circulation

1-24 a The vision of the Global Reporting Initiative (GRI) is a sustainable

global economy where organizations manage their economic, environmental, social and governance performance and impacts responsibly, and report transparently Its mission is to make sustainability reporting standard practice by providing guidance and support to organizations

b According to the GRI ―A sustainability report is a report published

by a company or organization about the economic, environmental, and social impacts caused by its everyday activities A sustainability report also presents the organization's values and governance model, and demonstrates the link between its strategy and its commitment to a sustainable global economy.‖

In an integrated report, sustainability information is included along with financial information These reports emphasize the links between financial and non-financial performance An integrated report also presents the risks and opportunities the company faces, integrated with disclosure of environmental, social, and governance issues

c GRI offers two ―in accordance‖ reporting options, Core and

Comprehensive For each option, there is a corresponding claim, or statement of use, that the organization is required to include in the report The Core report provides the essential elements of a sustainability report The Comprehensive report includes additional disclosures of the organization‘s strategy and analysis, governance, and ethics and integrity The GRI recommends external assurance, but it is not required for either type of ―in accordance‖ report

1-25 a Answers will vary by state Most states require 150 hours of

education, with specific requirements for number of accounting hours and credit hours in other subject areas

b Answers will vary by state Many states require one or two years of

work experience gained in public practice, or possibly government, academia or industry, depending on the state In many states, experience in industry or internal audit is sufficient, depending on the type of work performed

c Most states have frequently addressed questions Many of these

address education requirements, as well as information on how to prepare for the exam, as well as information on applying for licensure

d The Elijah Watt Sells award program was established in 1923

by the American Institute of Certified Public Accountants (AICPA) to recognize outstanding performance on the Uniform CPA Examination The award is presented to candidates who obtained a cumulative average score above 95.50 across all four sections of the Uniform CPA Examination, completed testing during the previous calendar year, and passed all four sections of the Examination on their first attempt

e Passing information is available on the CPA Examination portion of

the AICPA web site Recent passing rates have ranged from approximately 42% to 60% across the four sections

Chapter 2 The CPA Profession

 Concept Checks

P 29

1 The four major services that CPAs provide are:

a Audit and assurance services Assurance services are independent

professional services that improve the quality of information for decision

makers Assurance services include attestation services, which are any

services in which the CPA firm issues a report that expresses a conclusion

about the reliability of an assertion that is the responsibility of another party

The four categories of attestation services are audits of historical financial

statements, attestation on the effectiveness of internal control over financial

reporting, reviews of historical financial statements, and other attestation

services

b Accounting and bookkeeping services Accounting services involve preparing

the client’s financial statements from the client’s records Bookkeeping

services include the preparation of the client’s journals and ledgers as well as

financial statements

c Tax services Tax services include preparation of corporate, individual, and estate

returns as well as tax-planning assistance

d Management consulting and risk advisory services These services

range from suggestions to improve the client’s accounting system to advice

on risk management or on computer installations

2 The six organizational structures available to CPA firms are proprietorship,

general partnership, general corporation, professional corporation, limited

liability company, and limited liability partnership CPA firms are typically not

organized as a general partnership because a general partnership offers less

protection from legal liability relative to other structures such as a limited

liability partnership

P 38

1 The Public Company Accounting Oversight Board provides oversight for auditors of

public companies, including establishing auditing and quality control standards for

public company audits, and performing inspections of the quality controls at audit

firms performing those audits

Concept Checks (continued)

2 The AICPA is the organization that sets professional requirements for

CPAs The AICPA also conducts research and publishes materials on

many different subjects related to accounting, auditing, management

consulting and advisory services, and taxes The organization also

administers the Uniform CPA examination, provides continuing education to

its members, and develops specialty designations to help market and assure

the quality of services in specialized practice areas

3 International Standards on Auditing (ISAs) are issued by the International

Auditing and Assurance Standards Board (IAASB) of the International

Federation of Accountants (IFAC) and are designed to improve the

uniformity of auditing practices and related services throughout the

world AICPA Statements on Auditing Standards (SASs) are established by

the Auditing Standards Board of the AICPA, and are applicable to private

companies and other entities within the United States other than public

companies and broker dealers As a result of efforts by the Auditing

Standards Board of the AICPA to converge U.S standards with international

standards, AICPA auditing standards and International Standards on Auditing

are similar in most respects PCAOB Auditing Standards apply only to U.S

publicly traded companies and other SEC registrants, including

broker-dealers Because the PCAOB initially adopted existing standards established

by the Auditing Standards Board as interim auditing standards and the

PCAOB also considers international standards when setting standards,

standards for audits of U.S public and private companies are mostly similar

 Review Questions

2-1 The major characteristics of CPA firms that permit them to fulfill their social

function competently and independently are:

1 Organizational form A CPA firm exists as a separate entity to avoid an

employer-employee relationship with its clients The CPA firm employs

a professional staff of sufficient size to prevent one client from constituting a significant portion of total income and thereby endangering the firm’s independence

2 Conduct A CPA firm employs a professional staff of sufficient size to

provide a broad range of expertise, continuing education, and promotion of a professional independent attitude and competence

attempt to keep competence high

2-2 The Public Company Accounting Oversight Board (PCAOB) provides oversight

for auditors of public companies, including establishing auditing and quality control

standards for public company audits, and performing inspections of the quality controls at

audit firms performing those audits

2-3 The purpose of the Securities and Exchange Commission is to assist in providing

investors with reliable information upon which to make investment decisions Since

most reasonably large CPA firms have clients that must file reports with the SEC

each year (all companies filing registration statements under the securities acts of

1933 and 1934 must file audited financial statements and other reports with the SEC at

least once each year), the profession is highly involved with the SEC requirements

The SEC has considerable influence in setting generally accepted

accounting principles and disclosure requirements for financial statements because

of its authority for specifying reporting requirements considered necessary for

fair disclosure to investors In addition, the SEC has power to establish rules for any

CPA associated with audited financial statements submitted to the Commission

2-4 Statements on Standards for Attestation Engagements provide a framework for

attest engagements, including detailed standards for specific types of attestation

engagements

2-5 The PCAOB has responsibility for establishing auditing standards for U.S public

companies, while the Auditing Standards Board (ASB) of the AICPA establishes

auditing standards for U.S private companies Prior to the creation of the PCAOB, the

ASB had responsibility for establishing auditing standards for both public and private

companies Because existing auditing standards were adopted by the PCAOB as interim

auditing standards for public company audits, there is considerable overlap in the two sets

of auditing standards

2-6 International Standards on Auditing (ISAs) are issued by the International

Auditing and Assurance Standards Board (IAASB) of the International Federation of

Accountants (IFAC) and are designed to improve the uniformity of auditing practices

and related services throughout the world The IAASB issues pronouncements on

a variety of audit and attest functions and promotes their acceptance worldwide As a

result of efforts by the Auditing Standards Board to converge U.S GAAS with

international standards, AICPA auditing standards and International Standards on

Auditing are similar in most respects

2-7 Auditing standards represent pronouncements by any of the organizations

responsible for setting auditing standards In the U.S these standards are set by the

PCAOB for public companies and broker dealers, and by the Auditing Standards Board

of the AICPA for other entities Examples of auditing standards include any of the SASs

(e.g., SAS No 125), covering topics such as audit planning or assessing the risk of

material misstatement

Generally accepted accounting principles are specific rules for accounting for

transactions occurring in a business enterprise Examples may be any of the opinions of

the FASB, such as accounting for leases, pensions, or fair value assets

2-8 Auditors develop their competency and capabilities for performing an audit

through formal education in auditing and accounting, adequate practical

experience, and continuing professional education Auditors can demonstrate their

proficiency by becoming licensed to practice as CPAs, which requires successful

completion of the Uniform CPA Examination The specific requirements for licensure vary

from state to state

2-9 For the most part, auditing standards, including SASs, are general rather than

specific Many practitioners along with critics of the profession believe the standards

should provide more clearly defined guidelines as an aid in determining the extent

of evidence to be accumulated This would eliminate some of the difficult audit

decisions and provide a source of defense if the CPA is charged with conducting an

inadequate audit On the other hand, highly specific requirements could turn auditing into

mechanical evidence gathering, void of professional judgment From the point of view

of both the profession and the users of auditing services, there is probably a greater

harm from defining authoritative guidelines too specifically than too broadly

2-10 Quality controls are the procedures used by a CPA firm that help it meet its

professional responsibilities to clients Quality controls are therefore established for the

entire CPA firm as opposed to individual engagements

2-11 The element of quality control is personnel management The purpose of the

requirement is to help assure CPA firms that all new personnel are qualified to perform

their work competently A CPA firm must have competent employees conducting the

audits if quality audits are to occur

2-12 A peer review is a review, by CPAs, of a CPA firm’s compliance with its

quality control system A mandatory peer review means that such a review is required

periodically AICPA member firms are required to have a peer review every three

years Registered firms with the PCAOB are subject to quality inspections These

are different than peer reviews because they are performed by independent inspection

teams rather than another CPA firm

Peer reviews can be beneficial to the profession and to individual firms By

helping firms meet quality control standards, the profession gains if reviews result in

practitioners doing higher quality audits A firm having a peer review can also gain if it

improves the firm’s practices and thereby enhances its reputation and effectiveness, and

reduces the likelihood of lawsuits Of course, peer reviews are costly There is always a

trade-off between cost and benefits

 Multiple Choice Questions From CPA Examinations

2-16 a The main objective of an audit of financial statements is to obtain

reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion in a written report on whether the financial statements are presented fairly, in all material respects, in accordance with an applicable financial reporting framework

b Each entity faces a number of risks unique to the nature of its

business and industry The types of operations, the extent of regulation, how the organization obtains capital to fund its business model, and the nature of accounts in the financial statements, among other factors, result in different types of risks that could lead to material misstatements In addition, there are unique accounting standards for certain industries that impact how transactions, accounts, and disclosures are reported in financial statements Thus, a thorough understanding of the client’s business is critical to assessing the risk of material misstatements in the financial statements when planning the audit

c The auditor is responsible for obtaining sufficient appropriate audit

evidence about whether the financial statements are free of material misstatements In addition to understanding whether the amounts reported

in the financial statements are mathematically accurate, the auditor obtains other types of information to determine that the amounts reported represent valid transactions and accounts and that all valid transactions and accounts are included Evidence is also gathered to determine that the entity has the rights to assets and has the obligation to repay liabilities reflected in those financial statements and whether the correct disclosures are included in the financial statements as required by accounting standards

d No In an audit of the financial statements, the auditor performs audit

procedures to obtain reasonable assurance about whether the financial statements contain material misstatements While a high level of assurance, reasonable assurance is less than a guarantee―

which implies absolute (100%) assurance In an audit, the auditor issues

an opinion on whether the financial statements are presented fairly, but the auditor is not guaranteeing that the financial statements are accurate with certainty

e No Fraud is a broad legal concept that describes any intentional deceit

meant to deprive another person or party of their property or rights The auditor does not take responsibility for detecting all types of fraud

Instead, the auditor performs auditing procedures to obtain reasonable assurance that the financial statements do not contain material misstatements, whether due to fraud or error Thus, the auditor is concerned with detecting fraud that leads to a material misstatement The auditor is not responsible for detecting fraud that does not lead to a material misstatement

2-17 a Acceptance and continuation of clients and engagements

2-18 a The International Auditing and Assurance Standards Board (IAASB) of

the International Federation of Accountants (IFAC) is responsible for issuing International Standards on Auditing (ISAs) The ISAs do not override a specific country’s regulations governing the audit of financial statements

b The AICPA Auditing Standards Board (ASB) is responsible for issuing

standards in the U.S to be used by auditors when auditing the financial statements of all entities other than U.S publicly traded companies

The Public Company Accounting Oversight Board (PCAOB) is responsible for issuing standards to be used by auditors when auditing a U.S public company or other entities registered with the SEC (e.g., broker-dealers)

c The ASB has revised most of its standards to converge them with the

international standards As a result, U.S standards are mostly consistent with international standards, except for certain requirements that reflect unique characteristics of the U.S environment

d When developing a new SAS, the ASB uses the ISAs as the base

standard and then modifies that base standard only when appropriate for the U.S environment

e The PCAOB develops and issues its standards While the PCAOB

considers existing international standards, it does not start with the ISA standard as the base

f When conducting an audit of a client that is listed on both a foreign stock

exchange and a U.S stock exchange, the auditor would have to satisfy both the relevant international auditing standards as well as the PCAOB auditing standards This does not mean the auditor conducts two separate audits, but rather their procedures must satisfy both sets of standards, which will be similar in many ways but may also require the auditor to perform additional procedures required by one, but not the other, set of standards

2-19 a PCAOB auditing standards

b AICPA auditing standards

c PCAOB auditing standards

d AICPA auditing standards

e International auditing standards

f International auditing standards

g PCAOB auditing standards

h PCAOB auditing standards (reporting in Mexico will be under

international auditing standards)

i International auditing standards

The auditor must possess the

competency and capabilities

to perform the audit

It was inappropriate for Holmes to hire the two students to conduct the audit The audit must be conducted by persons with proper education and experience in the field of auditing Although junior assistants may not have completed their formal education, they may help in the conduct of the audit

as long as there is proper supervision and review

The auditor must comply

with ethical requirements, which

include maintaining independence

in mental attitude in all matters

relating to the audit

To satisfy this principle, Holmes must be without bias with respect to the client under audit Holmes has

an obligation for fairness to the owners, management, and creditors who may rely on the report Because of the financial interest in whether the bank loan is granted to Ray, Holmes is

independent in neither fact nor appearance with respect to the assignment undertaken

The auditor must maintain

professional skepticism and

exercise professional judgment in

the performance of the audit and

the preparation of the report

This principle requires Holmes to perform the audit with due care, which imposes on Holmes and everyone in Holmes’ organization a responsibility

to observe the principles of performance and reporting Maintaining professional skepticism and exercising professional judgment require critical review at every level of supervision of the work done and the judgments exercised by those assisting

in the audit Holmes did not review the work or the judgments of the assistants and clearly failed to adhere to this standard

2-20 (continued)

OF PRINCIPLE FAILURE TO COMPLY WITH PRINCIPLE

PERFORMANCE

PRINCIPLES

The auditor must adequately plan the

work and must properly supervise

any assistants

This principle recognizes that early appointment of the auditor has advantages for the auditor and the client Holmes accepted the engagement without considering the availability of competent staff In addition, Holmes failed to supervise the assistants

The work performed was not adequately planned

The auditor must identify and assess

the risks of material misstatement

based on a sufficient understanding

of the entity and its environment,

including its internal control, to

design the nature, timing, and

extent of further audit procedures

Holmes did not obtain an understanding of the entity

or its internal control, nor did the assistants obtain such an understanding There appears to have been

no audit at all The work performed was more an accounting service than it was an auditing service

The auditor must obtain sufficient

appropriate audit evidence by

performing audit procedures to

afford a reasonable basis for an

opinion regarding the financial

statements under audit

Holmes acquired no evidence that would support the financial statements Holmes merely checked the mathematical accuracy of the records and summarized the accounts Standard audit procedures and techniques were not performed

The auditor must express an opinion

in a written report about whether

the financial statements are

presented in accordance with the

applicable financial reporting

framework

The auditor must either express an

opinion regarding the financial

statements, taken as a whole, or

state that an opinion cannot be

expressed in the auditor’s report

When the auditor cannot express an

overall opinion, the auditor should

state the reasons therefor in the

auditor’s report In all cases where

an auditor’s name is associated

with financial statements, the

auditor should clearly indicate the

character of the auditor’s work, if

any, and the degree of

responsibility the auditor is taking,

in the auditor’s report

Holmes’ report made no reference to generally accepted accounting principles Because Holmes did not conduct a proper audit, the report should state that no opinion can be expressed as to the fair presentation of the financial statements in

accordance with generally accepted accounting principles

Although Holmes’ report contains an expression of opinion, such opinion is not based on the results of

a proper audit Holmes should disclaim an opinion because he failed to conduct an audit in accordance with auditing standards

The auditor must assess whether the

financial statements are presented

in accordance with the financial

reporting framework

Holmes‘ improper audit would not enable him to determine whether generally accepted

accounting principles were followed

Management is primarily responsible for adequate disclosures in the financial statements, but when the statements do not contain adequate disclosures the auditor should make such disclosures in

the auditor‘s report In this case both the statements and the auditor‘s report lack adequate disclosures

2-21

a AU-C 315 is an AICPA standard that address understanding the entity and

its environment and assessing the risk of material misstatement

b PCAOB standard AS 2305: Substantive Analytical Procedures is

analogous to AICPA standard AU-C 520: Analytical Procedures and ISA 520: Analytical Procedures Note that the number and title of the AICPA and IAASB standard are identical

c SAS No 128: Using the Work of Internal Auditors is AU-C Section 610

2-22

a Six of the 10 largest firms generate the largest percentage of revenue from

consulting The percentage of revenue from consulting reflects both the types of services offered, and how long the firm has offered the service

For example, of the Big 4 firms, Deloitte earns the highest percentage of its revenue from consulting because it never sold any of its consulting practice The other three Big 4 firms sold or spun-off their consulting practices in the period immediately before passage of the Sarbanes-Oxley

Act

b Consulting services will improve audit quality if the services expand the

technical abilities of the CPA firm For example, the consulting practice may include valuation experts that can assist with audit valuation issues

Consulting services may negatively impact audit quality if the CPA firm places greater emphasis on consulting than providing quality audit services Note that auditors are restricted from providing most consulting services to public company audit clients, so providing consulting normally does not impact auditor independence

Chapter 3 Audit Reports

 Concept Checks

P 62

3 The standard unmodified opinion audit report for a nonpublic entity contains the

following eight parts:

1 Report title: Auditing standards require that the report be titled and that the

title includes the word independent

2 Audit report address: The report is usually addressed to the company, its

stockholders, or the board of directors

3 Opinion section: The first section in the standard report, which must include

the title ―Opinion‖, states the auditor’s conclusions based on the results of the audit The first paragraph of the report makes the simple statement that

the CPA firm has done an audit Second, it lists the financial statements

that were audited, including the balance sheet, income statement,

statement of cash flows, and footnotes The second paragraph contains the auditor’s opinion as to whether the financial statements present fairly in all material respects the financial position and results of operations in accordance with the relevant accounting standards (e.g., U.S GAAP)

4 Basis for Opinion: The basis for opinion paragraph indicates that the auditor

conducted the audit in accordance with the relevant auditing standards This paragraph must also include an affirmative statement that the auditor is independent and has followed the relevant ethical standards Finally, this paragraph includes a statement that the auditor believes the audit evidence obtained is sufficient and appropriate and provides a basis for the opinion

5 Management’s responsibility: This section indicates that the financial

statements are the responsibility of management, including selecting appropriate accounting principles and maintaining internal control over financial reporting This section also acknowledges management’s responsibility to assess whether there is substantial doubt about the entity’s ability to continue as a going concern

6 Auditor’s responsibility: The auditor’s responsibility section of the

report includes three paragraphs and must include the heading ―Auditor’s Responsibilities for the Audit of the Financial Statements‖

Concept Check, P 62 (continued)

The first paragraph indicates that the auditor’s objectives are to obtain reasonable assurance about whether the financial statements are free of material misstatement whether due to error or fraud, and to issue an opinion

This paragraph defines reasonable assurance, and highlights that the risk of failing to detect a material misstatement due to fraud is greater than the risk due to an error

The second paragraph briefly describes important aspects of an audit, including that the procedures depend on the auditor’s professional judgment and assessment of the risks of material misstatement This paragraph also indicates that the auditor considers the entity’s internal control, but not for the purposes of expressing an opinion on the effectiveness of internal control over financial reporting The last two bullet points of the paragraph indicate that the audit includes evaluating the appropriateness of accounting policies selected, the reasonableness of accounting estimates, and the overall financial statement presentation, as well as evaluating the entity’s ability to continue as a going concern

The third paragraph indicates that the auditor is required to communicate certain matters to those charged with governance, such as the planned scope and timing of the audit, significant findings, and internal control matters

practitioner who performed the audit, and the city and state where the auditor is located

the auditor completed the auditing procedures needed to obtain sufficient appropriate evidence to support the opinion

4 The most significant differences between a standard unmodified opinion under

AICPA and PCAOB auditing standards (referred to as an unqualified opinion) are the

inclusion or exclusion of certain sections of the report, such as a discussion of critical

audit matters in a PCAOB report, and a reference to a report on the audit of internal

controls in a PCAOB report for large public companies The Basis for Opinion

section of the PCAOB report references the PCAOB auditing standards, and indicates

the financial statements are the responsibility of management, whereas the auditor’s

responsibility is to express an opinion on the financial statements This is in contrast

to the separate and more detailed AICPA audit report sections on management’s

responsibility and the auditor’s responsibilities

The most significant difference in the reports is that the PCAOB now requires

a discussion of critical audit matters While the AICPA report allows a discussion of

key audit matters, the discussion of critical audit matters, if any, is required by the

PCAOB One additional difference is that the PCAOB now requires the disclosure of

the tenure of the auditor-client relationship

Concept Check, P 62 (continued)

5 The auditor should include an explanatory paragraph in an unmodified opinion audit

report when the audit is completed with satisfactory results and the financial

statements are fairly presented, but the auditor believes it is important to draw the

reader’s attention to certain matters or the auditor is required to provide additional

information The following are the most important causes of the addition of an

emphasis of matter explanatory paragraph or a modification in the wording of the

standard unmodified opinion audit report:

a Lack of consistent application of generally accepted accounting principles

b Substantial doubt about going concern

c Auditor agrees with a departure from promulgated accounting principles

d Emphasis of other matters

e Reports involving other auditors

P 73

1 The three conditions requiring a departure from an unmodified opinion are:

1 The scope of the audit has been restricted One example is when the client will

not permit the auditor to confirm material receivables Another example is when

the engagement is not agreed upon until after the client’s year-end when it may be

impossible to physically observe inventories

2 The financial statements have not been prepared in accordance with generally

accepted accounting principles An example is when the client insists upon using

replacement costs for fixed assets

3 The auditor is not independent An example is when the auditor owns stock in

the client’s business

2 The three alternative opinions that may be appropriate when the client’s financial

statements are not in accordance with GAAP are an unmodified opinion, qualified

opinion, and adverse opinion Determining which is appropriate depends entirely upon

materiality An unmodified opinion is appropriate if the GAAP departure is

immaterial (standard unmodified) or if the auditor agrees with the client’s

departure from GAAP (unmodified with explanatory paragraph) A qualified

opinion is appropriate when the deviation from GAAP is material but not highly

material; the adverse opinion is appropriate when the deviation is highly material

 Review Questions

3-1 Auditors’ reports are important to users of financial statements because they

inform users of the auditor’s opinion as to whether or not the financial statements are

fairly stated or whether no conclusion can be made with regard to the fairness of their

presentation Users especially look for any deviation from the wording of the standard

unmodified report and the reasons and implications of such deviations Having standard

wording improves communications for the benefit of users of the auditor ’s report

When there are departures from the standard wording, users are more likely to

recognize and consider situations requiring a modification or qualification to the

auditor’s report or opinion

3-2 The opinion section appears first in the report due to its importance The purpose

of the opinion section is to state the auditor’s conclusions based upon the results of the

audit evidence The most important information in the opinion section includes:

1 The words ―in our opinion,‖ which indicate that the conclusions are based

on professional judgment

2 A statement about whether the financial statements were presented fairly

and in accordance with generally accepted accounting principles along with indication of the fiscal year(s) associated with those statements

3-3 The purposes of the auditor’s responsibility section of the report are to inform

the financial statement users of the objective of the audit and the nature of the audit

procedures performed The information in the auditor’s responsibility section includes:

1 Stating that the objective of the audit is to obtain evidence about whether

the financial statements are free of material misstatements whether due to error or fraud, and to issue an audit opinion

2 Define reasonable assurance as a high level of assurance, but not absolute

assurance

3 An audit involves performing procedures to obtain audit evidence about

the amounts and disclosures in the financial statements

4 The audit procedures selected depend on the auditor’s judgment, and

consider the auditor’s assessment of the risks of material misstatement, whether due to fraud or error

5 As part of this risk assessment, the auditor considers internal control

over financial reporting in the design of the audit procedures The assessment is not for the purpose of expressing an opinion on internal control over financial reporting, and the auditor does not express such

an opinion

6 An audit includes evaluating the appropriateness of the accounting

policies used, the reasonableness of significant estimates, the overall presentation of the financial statements, and the entity’s ability to continue

as a going concern

3-4 Note that this review problem should have indicated that the auditor completed all

of the evidence gathering procedures on February 17, 2020 for the audit of the financial

statements for the fiscal year ended December 31, 2019 Under that scenario, the

auditor’s report should be dated February 17, 2020, the date on which the auditor

concluded that he or she had sufficient appropriate evidence to support the auditor’s

opinion

3-5 A standard unmodified opinion audit report may be issued under the following

circumstances:

1 All statements—balance sheet, income statement, statement of

retained earnings, and statement of cash flows—are included in the financial statements

2 Sufficient appropriate evidence has been accumulated and the auditor

has conducted the engagement in a manner that enables him or her to conclude that the audit was performed in accordance with auditing standards

3 The financial statements are presented in accordance with

appropriate accounting standards such as U.S generally accepted accounting principles or IFRS This also means that adequate disclosures have been included in the footnotes and other parts of the financial statements

4 There are no circumstances requiring the addition of an explanatory

paragraph or modification of the wording of the report

3-6 The opinion and basis for opinion sections include reference to management’s

report on internal control over financial reporting, and the scope of the auditor’s work

and opinion on internal control over financial reporting The basis for opinion

paragraphs also refer to the framework used to evaluate internal control Two additional

paragraphs are added below the basis for opinion paragraphs that define internal control

and describe the inherent limitations of internal control There is also a cross reference

paragraph between the opinion and the basis for opinion paragraphs that references the

report on the audit of the financial statements

3-7 The standard unmodified opinion audit report for a nonpublic entity under AICPA

auditing standards and the standard unqualified report for a public company under PCAOB

auditing standards are very similar in substance Both reports begin with the opinion

paragraphs The PCAOB report also references the opinion on the audit of internal

control over financial reporting The PCAOB report includes the responsibilities of

management and the auditor within the basis for opinion section, while the report for the

nonpublic entity in Figure 3-1 has separate sections for management’s and the

auditor’s responsibility These paragraphs provide additional information on the nature

of these responsibilities, including the responsibility of management and the auditor to

evaluate whether there are conditions that raise substantial doubt about the entity’s ability

to continue as a going concern

3-7 (continued)

Finally, The PCAOB report contains a section for critical audit matters, whereas a

discussion of key audit matters is only included in the report for nonpublic entities if the

terms of the audit engagement require such disclosure

3-8 Revisions to the PCAOB audit report, including the requirement to include a

discussion of critical audit matters, are intended to provide more information to users of

financial statements In particular, the disclosure of critical audit matters provides

information to users about areas considered high risk by the auditor, and areas requiring

significant auditor judgment This makes a financial statement user aware that not all

account balances or related disclosures may have the same level of assurance For each

critical audit matter (CAM) communicated in the audit report, the auditor must identify

the CAM, describe the considerations that led the auditor to identify the area as a CAM,

describe how the matter was addressed in the audit, and refer a reader to the relevant

accounts or related disclosures in the financial statements

Two examples of areas that might be considered critical audit matters in the audit

of a public company in the hotel and lodging industry include revenue and leased

property Revenue in the lodging industry is highly material, depends on occupancy rates,

and room rates that vary based on the location of the property, the day of the week, time

of year, and the source of the booking For all of these reasons, revenue requires

extensive testing and auditor judgment In the lodging industry, properties can either be

owned or leased, and many hotel companies have various arrangements depending on the

type of lodging (e.g., hotels, timeshare properties, etc.) Hotels may have an incentive to

report property as being owned or leased under certain categories, and thus this area

requires extensive testing by the auditor

3-9 An unmodified opinion audit report with an explanatory paragraph or modified

wording is the same as a standard unmodified opinion report except that the auditor

believes it is necessary to provide additional information about the audit or the

financial statements For a qualified report, either there is a scope limitation (condition

1) or a failure to follow generally accepted accounting principles (condition 2)

Under either condition, the auditor concludes that the overall financial statements are

fairly presented

Two examples of an unmodified opinion audit report with an explanatory

paragraph or modified wording are:

1 The entity changed from one generally accepted accounting principle to

another generally accepted accounting principle

2 A shared report involving the use of other auditors

3-10 When another CPA has performed part of the audit, the primary auditor issues one

of the following types of reports based on the circumstances

1 No reference is made to the other auditor This will occur if the other

auditor audited an immaterial portion of the financial statements, the other auditor is known or closely supervised, or if the principal auditor has thoroughly reviewed the other auditor’s work

2 Issue a shared opinion in which reference is made to the other auditor

This type of report is issued when it is impractical to review the work of the other auditor or when a portion of the financial statements audited

by the other CPA is material in relation to the total

3 The report may be qualified if the principal auditor is not willing to

assume any responsibility for the work of the other auditor A disclaimer may be issued if the segment audited by the other CPA is highly material

3-11 Even though this change has been reflected in the financial statements, a separate

explanatory paragraph is required to explain the change in generally accepted accounting

principles in the first year in which the change took place

3-12 Changes that affect the consistency of the financial statements may involve

any of the following:

a Change in accounting principle

b Change in reporting entity

c Corrections of errors involving accounting principles

An example of a change that affects consistency would be a change in the

method of computing depreciation from straight line to an accelerated method A

separate explanatory paragraph is required if the amounts are material

Comparability refers to items such as changes in estimates, presentation, and

events rather than changes in accounting principles For example, a change in the

estimated life of a depreciable asset will affect the comparability of the statements In

that case, no explanatory paragraph for lack of consistency is needed because the

same method of depreciation is used in both years, but the information may require

disclosure in the statements

3-13 When the audit report contains a qualified opinion, the eight elements of the

standard audit report are as follows:

1 Report title: Same as standard unmodified opinion report

2 Audit report address: Same as standard unmodified opinion report

3-13 (continued)

3 Opinion section: The introductory paragraph in the opinion section is the

same as in the standard unmodified opinion report The second paragraph

containing the opinion is modified to include the term except for in the opinion

paragraph

4 Basis for opinion section: A new paragraph is added that describes the basis

for the qualified opinion The standard paragraph is modified to state that the

audit evidence obtained provides a sufficient and appropriate basis for the

qualified audit opinion

5 Management’s responsibility: Same as standard unmodified opinion report

6 Auditor’s responsibility: Same as the standard unmodified opinion report

7 Signature and Address of CPA firm: Same as standard unmodified opinion

report

8 Audit report date: Same as standard unmodified opinion report

3-14 A qualified opinion states that there has been either a limitation on the scope of

the audit of material accounts, transactions, or disclosures or a material departure from

GAAP in the financial statements, but that the auditor believes that the overall financial

statements are fairly presented This type of opinion may not be used if the auditor

believes the exceptions being reported upon are extremely material, in which case a

disclaimer or adverse opinion would be used

An adverse opinion states that the auditor believes the overall financial statements

are so materially misstated or misleading that they do not present fairly in accordance

with GAAP the financial position, results of operations, or cash flows

A disclaimer of opinion states that the auditor has been unable to satisfy himself

or herself as to whether or not the overall financial statements are fairly presented

because of a significant limitation of the scope of the audit, or a non-independent

relationship under the AICPA Code of Professional Conduct between the auditor and the

client

Examples of situations that are appropriate for each type of opinion are as

follows:

Qualified Inability to confirm the existence of an asset

which is material but not extremely material in value

Adverse A highly material departure from GAAP

Disclaimer Material physical inventories not observed

and the inventory cannot be verified through other procedures

Lack of independence by the auditor

3-15 A qualified report due to a scope limitation is issued when the auditor can

neither perform procedures that he or she considers necessary nor satisfy himself or

herself by using alternative procedures, usually due to the existence of conditions

beyond the client’s or the auditor’s control, but the amount involved in the financial

statements is not highly material An important part of a qualified opinion due to a scope

limitation is that it results from not accumulating sufficient appropriate audit evidence,

either because of the client’s request or because of circumstances beyond anyone’s

control When the opinion is qualified due to a scope limitation, the auditor modifies

both the basis for opinion and the opinion sections of the report The basis for opinion

section is modified to indicate that the auditor’s scope has been restricted and the

opinion paragraph is modified to include the qualified opinion

A report qualified due to a GAAP departure results when the

auditor has accumulated sufficient appropriate evidence but has concluded that

the financial statements are not correctly stated The only circumstance in which

an qualified opinion for a GAAP departure is appropriate is for material, but not

highly material, departures from GAAP When the opinion is qualified due to a

GAAP departure, the opinion paragraph is modified to include the qualified

opinion (including the ―except for‖ wording) The basis for opinion section is

modified by adding a new paragraph that describes the GAAP departure, and

modifying the basis for opinion paragraph to state that the audit evidence

obtained provides a sufficient and appropriate basis for the qualified audit opinion

3-16 The common definition of materiality as it applies to accounting and,

therefore, to audit reporting is:

A misstatement in the financial statements can be considered material if

knowledge of the misstatement would affect a decision of a reasonable user of

the statements

Conditions that affect the auditor’s determination of materiality include:

 Potential users of the financial statements

 Dollar amounts of the following items: net income before taxes, total

assets, current assets, current liabilities, and owners’ equity

 Nature of the potential misstatements—certain misstatements, such as

fraud, are likely to be more important to users of the financial statements than other misstatements

3-17 Materiality for lack of independence in audit reporting is easiest to define If the

auditor lacks independence as defined by the AICPA Code of Professional Conduct, it

is always considered highly material and therefore a disclaimer of opinion is always

necessary That is, either the CPA is independent or not independent For failure to

follow GAAP, there are three levels of materiality: immaterial, material, and highly

material

3-18 The auditor’s opinion may be qualified by scope limitations caused by client

restrictions or by limitations resulting from conditions beyond the client’s control The

former occurs when the client will not, for example, permit the auditor to confirm

material receivables or physically observe inventories The latter may occur when the

engagement is not agreed upon until after the client’s year-end when it may not be

possible to physically observe inventories or confirm receivables

A disclaimer of opinion is issued if the scope limitation is so material that the

auditor cannot determine if the overall financial statements are fairly presented If

the scope limitation is caused by the client’s restriction, the auditor should be aware

that the reason for the restriction might be to deceive the auditor For this reason, a

disclaimer is more likely for client restrictions than for conditions beyond anyone’s

control

When there is a scope restriction that results in the failure to verify

material, but not pervasive accounts, a qualified opinion may be issued This is more

likely when the scope limitation is for conditions beyond the client ’s control than

for restrictions by the client

3-19 When the auditor discovers more than one condition that requires a

departure from or a modification of a standard opinion audit report, the report

should be modified for each condition An exception is when one condition

neutralizes the other condition An example would be when the auditor is not

independent and there is also a scope limitation In this situation the lack of

independence overshadows the scope limitation Accordingly, the scope limitation should

 Discussion Questions and Problems 3-23 a ―Correctly stated‖ implies absolute accuracy, whereas the alternative report

states that no material misstatements exist

b The reference to generally accepted accounting principles specifies rules

that were followed in accounting for the transactions to date, whereas

―the true economic conditions‖ does not identify the specific accounting procedures applied

c The opinion paragraph is not intended to be a certification or a

guarantee of the accuracy and correctness of the financial statements, but rather it is intended to be an expression of professional judgment based upon a reasonable audit of the statements and underlying records

d The name of the CPA firm rather than that of the individual

practitioner should appear on the accountant’s report because it is the entire firm that accepts responsibility for the report issued

e ―Our audit was performed to detect material misstatements in the

financial statements‖ is flawed because the purpose of the audit is to determine whether financial statements are fairly stated, not to specifically search for material errors and fraud It also fails to

recognize the audit standards followed by the auditor

―We conducted our audit in accordance with auditing standards

generally accepted in the United States of America‖

identifies the auditor‘s responsibilities for the conduct of the audit, accumulation of evidence, and reporting requirements It is a much broader statement than the alternative clause It also implies that if the auditor has conducted the audit in accordance with generally accepted auditing standards but does not uncover certain material errors or fraud, the auditor is unlikely to have responsibility for failing to do so

3-24 a Items that need not be included in the auditor‘s report are:

1 Patel may or may not choose to add an explanatory paragraph that

highlights the recent acquisition of Stockard Inc., which is disclosed in the financial statements There would be no requirement to include that as an explanatory paragraph

2 Patel may or may not choose to add an explanatory paragraph

about the issuance of the debentures, which is disclosed in the footnotes There would be no requirement to include that as an explanatory paragraph

b The following deficiencies are in Patel’s report:

1 Bellamy is presenting comparative financial statements, and both

years’ statements should be referred to in the audit report There are comparative statements, but the audit report

3-24 (continued)

identifies and deals with only the current year’s financial statements An opinion must also be included for the prior period financial statements

2 Since Bellamy is a private company, the report should comply with

reporting requirements in AICPA auditing standards The audit report is neither addressed nor dated, and it does not contain a title, nor proper headings for each section of the report The audit report date should be the date on which the auditor completed the audit procedures needed to obtain sufficient appropriate evidence

3 The balance sheet is as of a specific date, whereas the

income statement and the statement of retained earnings are for

a period of time The introductory paragraph should identify the period of time (usually one year)

4 The basis for opinion paragraph needs to be expanded to state

that the auditor is independent and has fulfilled their ethical responsibilities in accordance with relevant ethical requirements

The sentence related to obtaining reasonable assurance should be included in a separate section on the auditor’s responsibilities

5 There is no separate management’s responsibility section that

states the responsibilities of management

6 There is no separate auditor’s responsibility section that defines

reasonable assurance and states the responsibilities of the auditor

in conducting an audit in accordance with GAAS

7 The report incorrectly states the audit was conducted in

accordance with generally accepted accounting standards rather than auditing standards generally accepted in the United States

of America

8 The word material is excluded from the statement that

should be part of the auditor’s responsibility (free of material misstatement)

9 Additional paragraph(s) should be included that describe the

limitation on the scope related to audit testing for accounts receivable, and the failure to include disclosure of the loss contingency related to pending litigation

10 The opinion paragraph states that accounting principles were

consistent with those used in the prior year The opinion paragraph should make no reference to consistency

11 The opinion paragraph excludes the required phrase, ―in all

material respects.‖

12 The opinion paragraph includes the words ―generally accepted

auditing standards‖ rather than the phrase ―accounting principles generally accepted in the United States of America.‖

3-24 (continued)

13 The opinion should be qualified rather than being unmodified

Qualifications are caused by the:

(a) failure to disclose the loss contingency

(b) scope restriction in the audit of accounts receivable

3-25

(a)

CONDITION

(b) MATERIALITY LEVEL

(7) Adverse (if highly material)

or (4) Qualified opinion

— GAAP departure (if material)

Disclosure of this information is required in a footnote Failure to

do so is a violation of GAAP and

is likely to result in a qualified opinion, or it could be so material that it requires an adverse opinion

2 Scope of the

audit has

been

restricted

Highly material (6) Disclaimer Failure of the client to allow the

auditor to inspect the board minutes would be a material client-imposed restriction Due

to the importance of the minutes,

a disclaimer would be necessary The certified copy of all

resolutions and actions would not be a satisfactory alternative procedure

Because the auditor was able to obtain alternative evidence, no scope qualification is necessary

If there were such a qualification, the opinion would be qualified or

a disclaimer, depending on materiality